Tax friendly trusts swell under new rules

Tax friendly trusts swell under new rules
© Greg Nash

U.S. companies are latching on to an obscure real estate provision to avoid corporate taxes, widely adopting a financial maneuver that has been expanded under the Obama administration.

Real estate investment trusts, or REITs, have been around for more than a half-century and were created by Congress to entice ordinary taxpayers to invest in shopping centers and office buildings.

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But just this year, the IRS released new rules that signaled the agency broadly defines what constitutes real estate, opening it up to areas such as a telecommunications company’s fiber optic and copper networks.

Those regulations have prompted some companies to spin off their real estate into a new company that’s effectively exempted from corporate taxes.

“What’s happened here is a lot of assets that normal people wouldn’t think of as real estate [are] now considered real estate,” Howard Gleckman of the Urban-Brookings Tax Policy Center said. “And now you’ve got another way to eliminate the corporate-level tax.”

The increased interest from the corporate world has created new business opportunities for K Street operatives, who are trying to keep Congress from reining in the rules governing REITs while encouraging the Obama administration to keep the approval letters coming.

But at the same time, President Obama and top administration officials are calling out Burger King and other corporations seeking to reincorporate abroad through a process called “inversion.”

Obama has dubbed those companies “corporate deserters.” But tax analysts say that the IRS appears unworried about the revenue implications of its decision about what constitutes real estate, instead asking how permanent is the property in question.

A spokeswoman for the Treasury Department suggested the administration might be giving the use of the real estate trusts a second look.

“We at Treasury are looking into the issues presented by these transactions and considering what action, if any, might be appropriate,” a spokeswoman said.

In July, an Arkansas-based phone company called Windstream announced that it was spinning off its fiber optics and copper networks into a new publicly traded REIT.

Windstream, whose stock jumped after the announcement, said it would rent back its own equipment for $650 million a year. The new arrangement, the company said, would allow it to slash its debt and increase its broadband investments.

Gleckman and other tax analysts said the Windstream decision was the IRS’s first real head scratcher when it came to REITs.

Still, there’s no doubt that an increasingly diverse group of companies has created new real estate trusts since Congress created them in 1960. Fifteen years ago, for instance, the hotel giant Host Marriott converted to a REIT.

Before Windstream’s move this year, one of the most controversial REIT conversions was Penn National Gaming’s decision to spin off its real estate in casinos into a new company.

Under that arrangement, Penn National’s casino licenses didn’t go to the new company, raising questions about how much the building housing a casino is worth without the license.

Elsewhere, the Corrections Corporation of America has spun off its for-profit prisons as REITs. 

Iron Mountain, the document management company, has also converted, as have companies that own cellphone towers. 

“We’ve been building up to Windstream for quite awhile. It’s a logical progression from hotels to prisons, casinos, hospitals,” said Lee Sheppard, a columnist at Tax Analysts who has closely watched the deals. “But when you get to Windstream, now you’re talking about buried wires in the REIT itself.”

Advocates for the trusts say it’s unfair to lump REITs in with corporate inversions, and even analysts that question the broader rules say converting to a REIT isn’t for everyone.

For starters, REITs don’t have to pay corporate taxes. But shareholders do pay taxes on the dividends that REITs pay out with sometimes more than the top corporate rate of 35 percent. The companies also must get at least three-quarters of its income from the rent or sale of real property. 

Officials at the National Association of Real Estate Investment Trusts (NAREIT) said the rules show that it’s too simplistic to examine the trusts’ impact on corporate tax revenues.

“With a conversion to a REIT, you end up with a situation where shareholders are paying taxes,” said Dara Bernstein, a senior tax counsel at the advocacy group. 

NAREIT officials also said that most trusts weren’t conversions like Windstream or Penn Gaming, but instead formerly privately held companies that decided to go public. They also defended the recent IRS regulations, saying that technological advancements since 1960 have also changed what constitutes real estate.

“The REIT industry today is not the product of conversions,” said Ron Kuykendall, a spokesman for the group.

Gleckman also noted that there hasn’t exactly been a flood of REIT conversions since Windstream. Life Time Fitness, a Minnesota-based gym company, said last month it was exploring such a move.

“There’s still obstacles for it to be feasible for everybody, or even a good idea,” said Sheppard. “But if it works, it works pretty well.”

Still, the current REIT setup also underscores the various avenues that lawyers and tax planners have to lower corporate tax bills, and lawmakers have taken notice.

House Ways and Means Committee Chairman Dave Camp (R-Mich.) proposed making it harder for companies to get the tax benefits from spinning off real estate trusts in his tax reform draft this year, a change that would save the government around $6 billion over a decade.

A GOP aide said that even some advocates for the real estate trusts expressed concerns about the increasing popularity of that maneuver, making it easier for Camp to propose the change.

Camp’s tax reform proposal gained little traction, even among Republicans. But lobbyists are also working furiously to ensure keep the current rules intact whenever the tax reform debate heats up again.

Lawyers at Skadden Arps, for instance, called Camp’s draft “highly disruptive” to the practice of using REITs and said it showed that “certain corners of the REIT universe are perceived as a source of potential revenue to be harvested.”

Now, K Street is mobilizing to ensure that any sort of tax reform doesn’t shift the Treasury’s view on the property investment trusts.

In the first half of this year, there were 50 quarterly reports filed by companies, trade groups and lobbying firms that listed advocacy work on real estate investment trusts, according to federal lobbying disclosures. Firms filed around 90 reports on REITs in 2012, but the amount of disclosures had typically been much smaller in previous years.

The forestry industry has long been a beneficiary of the REIT process, and top timber companies such as Plum Creek and Weyerhaeuser have K Street teams working on the policies.

NAREIT spent $3.74 million on lobbying last year, an all-time high for the trade group, by far. 

The Corrections Corporation of America began lobbying on REITs this year and data-center operator Equinix, which announced plans to convert to a real estate investment trust by 2015, signed up with Squire Patton Boggs in April. In the past, energy companies and shopping malls have also lobbied on the issue.

 

Companies “know that all things in Washington can turn political,” said one lobbyist working on the issue. “And they’d rather have their applications considered in the current environment than an uncertain future environment.”